April 1917–September 1918
« Any great war must necessarily be a popular movement. It is a kind of crusade; and like all crusades, it sweeps along on a powerful stream of romanticism. »
World War I began in Europe in 1914, the same year the Federal Reserve System was established. During the three years it took for the United States to enter the conflict, the Fed had completed its organization and was in a position to play a key role in the war effort. Wars are expensive and, like every governmental effort, they have to be financed through some combination of taxation, borrowing, and the expedience of printing money. For this war, the federal government relied on a mix of one-third new taxes and two-thirds borrowing from the general population. Very little new money was created. These securities were issued by the Treasury, but the Federal Reserve and its member banks conducted the bond sales.
Generally speaking, the secretary of the Treasury proposes a funding plan for war financing and works with Congress to enact the necessary legislation, while the Federal Reserve operates with considerable independence from both the executive and legislative branches of government. But World War I was different. The Treasury and the Fed, united under one leader, worked together in both the creation of the financial war plan and its execution.
In the congressional debates over the structure of the Federal Reserve, the makeup of the Federal Reserve Board and even its very existence were key issues. The chair of the House Banking and Currency Committee, Rep. Carter Glass, opposed the idea of a central coordinating board. President Woodrow Wilson, however, insisted on a public agency with supervisory powers over the banks. The resulting compromise created a seven-member Federal Reserve Board seated in Washington, DC, with the secretary of Treasury designated ex officio as chair. 1 The other members were the comptroller of the currency and five members appointed by the president and confirmed by the Senate. Wilson’s secretary of the Treasury, William Gibbs McAdoo, designed and arranged that compromise, and he emerged from the deal in charge of both the Treasury and the Federal Reserve. Congress cleared the bill in December 1913. 2
When the United States entered World War I in 1917, it became immediately evident that an unprecedented effort would be required to divert the nation’s industrial capacity away from meeting consumer demand and toward fulfilling the needs of the military. At the time of the congressional erican economy was operating at full capacity, so the requirements of the war effort could not be met by putting underutilized resources to work. The wartime payday loans Oregon population would have to sacrifice to pay the bill, and McAdoo understood the point. Shortly after war had been declared, he delivered a speech that he later recorded for posterity:
« We must be willing to give up something of personal convenience, something of personal comfort, something of our treasure – all, if necessary, and our lives in the bargain, to support our noble sons who go out to die for us. »
But the question remained: how would the shift in output be arranged? How should the war be paid for? There were three possibilities: taxation, borrowing, and printing money.
For McAdoo, printing money was off the table. The experience with issuing “greenbacks” during the Civil War suggested that fiat money would generate inflation, which he thought would lower morale and damage the reputation of the newly issued paper currency, the Federal Reserve Note. McAdoo also opposed printing money because it would hide the costs of war rather than keeping the public engaged and committed. “Any great war must necessarily be a popular movement,” he thought, “… a kind of crusade.”